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Home >> Home Sellers  >> (Legal Issues) - Capital Gains

 

What Are Capital Gains?

 

 

Understanding Capital Gains in Real Estate

Calcilation of Capital Gains for Real Estate Investors.
We recommend that the calculation of Capital Gains should nearly always be left to the professional tax attorney or accountant. However, you should have a basic understanding of what could amount to a very large sum (even with the special consideration given to real estate) when you sell your home.

When you sell a stock, you owe taxes on your gain. The "gain" is the difference between what you paid for the stock and what you received for the stock when you sold it. If you made money on the transaction, the IRS will want a share of it  -- called a capital gains tax. The same is true with selling a home (or a second home), but the IRS gives your personal residence some special considerations.

The tax code is generous and excludes from taxes a large portion of home-sale profit. A single seller can walk away with up to $250,000 tax-free when he sells his primary residence; a married couple up to $500,000. See  A Special Real Estate Exemption for Capital Gains

But if you net more than that, you could be in for an astounding capital gains shock. And don't think it's just rich folk who are mired in this capital gains trap. People who have owned their homes for a long time in some skyrocketing real estate regions, may see substantial appreciation on their property. Home values in these regions may have quadrupled in only months, not years.

One of the questions that tax preparers and accountants hear all the time is: “I added a family room, and a patio, replaced the roof, and planted shrubbery. Can I take it off my taxes?” The answer - “No. Not until you sell your house.” So, save your receipts and keep good records of any improvements you make to your home because the cost of these improvements will be added to the purchase price of your home to determine the cost basis of the house when you sell it. The basis is subtracted from the sales price (with certain adjustments) to determine the gain or loss on the house.

How to Calculate the Capital Gain for Your Home

In real estate, capital gains are based not on what you paid for the home, but on its "adjusted cost basis." The "adjusted basis" is what you paid for the home plus your "out of pocket expenses" to date.

To calculate adjusted cost:

  1. Take the purchase price of the home: This is the actual sales price that you paid for the home, even if it was 30 years or more ago. (It is not the amount of money you actually contributed at closing, nor does it include all the interest you've paid on the home since.)
  2. Add adjustments:

    1. Cost of purchase — "what you paid for the home" including transfer fees, attorney fees, inspections, but not points you paid on your mortgage.
    2. Cost of improvements — including room additions, deck, etc. (Note  - It is here, that we tax payers most often run afoul of the tax code! As much as we would like to call them improvements, they do not include repairing or replacing something already there, such as putting on a new roof or buying a new furnace.)

      1. Just because you spent $20,000 to "improve" the look of your kitchen, does not mean it was an "improvement" in the eyes of the IRS. However, if you "added" a fireplace to your kitchen in the process  -  that might be considered an improvement.
      2. If you operated a business from your home or rented a portion of your home to someone, part of your home improvements may already have been deducted as business expenses through depreciation. These will be subject to recapture. This tax consideration is beyond the scope of this discussion, so, if depreciation is involved, you'll probably need to consult your tax attorney or accountant before continuing, or remember to factor it in later.
      3. The IRS provides a nifty chart on page 8 of its Publication 523, Selling Your Home. Here you'll see projects the IRS considers as improvements.
      4. Please consult your tax attorney or accountant for guidance through this gooey, if not goofy,  part of the tax code.
    3. Cost of sale — attorney’s fee, real estate commission, survey, transfer taxes, etc. (Stop - do not include property taxes that you had to pay up to the date of closing. Yes property taxes are deductible - but not in this "adjusted cost basis" calculation.) Use our handy Net Profit Calculator to help you figure the costs associated with sale of your home.
    4. Cost of sale repairs — including inspections, money you spent to fix up your home just prior to sale or to satisfy buyer's home inspection concerns.
  3. The total of all four items in #2 above is the "adjusted cost basis" of your home.
  4. Subtract this adjusted cost basis from the amount you sold or for what expect to sell your home. This is your Capital Gain.  

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Understanding Section 1031
Section 1031 of the U.S. Internal Revenue Code allows investors to defer capital gains taxes on the exchange of like-kind properties. Taxpayers should never have to pay income taxes on the sale of property if they intend to reinvest the proceeds in similar or like-kind property.

See 1031 Exchange.

 

Capital Gain Calculator

Purchase Price
Improvements
Cost of Sale
Repairs
Sale Price
Capital GAINS:

DISCLAIMER: RE/MAX Valley Real Estate and it's associates are not qualified tax or legal advisors, therefore this calculator is not intended to take the place of a thoughtfully compiled and calculated capital gain amount which your accountant or tax attorney can help you prepare - it is presented solely for your education and example.

 

A Special Real Estate Exemption for Capital Gains

Since 1997, up to $250,000 in capital gains ($500,000 for a married couple)  is exempt from taxation on the sale of a home - if you meet the following criteria:

Also note  -- as of 2003, you also may qualify for this exemption if you meet what the IRS calls “unforeseen circumstances,” such as job loss, divorce, or family medical emergency. Consult a tax accountant or attorney to assist you in this sometimes complicated matter.

 

 

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